Why Wall Street Experts are Getting Nervous about this Rising Market

At the start of each year, the chief strategists at Wall Street firms analyze dozens of variables and make bold prognostications for the year ahead. They distill all of their conclusions into one simple number -- the S&P 500, and where it will reside one year hence.

As these strategists were putting their forecasts together, they surely noted that the S&P 500 was marching nicely higher. Trouble is, it keeps moving up and is starting to already breach the more conservative forecasters on the Street.

More than a few of these folks predicted the S&P 500 would end the year around 1,325. We've already surpassed that mark, and we've got 11 months to go! To be sure, other folks see a brighter finish. Here's a small sample of key market strategists, along with their year-end forecasts for the S&P 500.

Wells Fargo (NYSE: WFC)
December 2012 S&P 500 target: 1,325
This forecast was issued in early December 2011, and has already gotten one factor wrong. "Stocks seem destined to start the year troubled by ongoing sovereign debt struggles in Europe, waiting for another jolt from policymakers," was their off-the-mark prediction. To be fair, many investors had been waiting for another shoe to drop from Europe. And who knows, it still may happen.

Meanwhile, that cautious backdrop has possibly helped, as stocks have "climbed a wall of worry." In effect, most rallies only come when a group of investors takes a bearish view and stocks get underpriced as those worries filter in. Worries about Europe have receded, which counter-intuitively, is a bearish sign because there is no wall to climb.

How did Wells Fargo arrive at that 1,325 S&P 500 target? They expected aggregated profits for all 500 companies in the index would rise 4% this year, and suggested that an environment of low inflation and low rates warranted a target P/E of 13 times earnings.

Wells Fargo's strategists say much will hinge on how Washington responds to the current budget problems. "The uncertain outlook for fiscal policy seems likely to continue to dampen confidence and create uncertainty for investors. In our view, the first concerted effort to cut the path of U.S. fiscal spending will be greeted with a sigh of relief," they note.

Curiously, as the battle for the Republican Party's Presidential nomination unfolds, budget pressures have fallen from the headlines -- and investor's consciousness. How long will that last?

Goldman Sachs (NYSE: GS)
December 2012 S&P 500 target: 1,250
This is a sobering forecast, implying the market has peaked and will actually head lower. Based on all of the global headwinds in place, Goldman's strategists say a price-to-earnings (P/E) ratio of around 11.8 times 2012 profits is the right multiple. And they derive that forecast with the assumption that the United States has tepid economic growth and Europe slips into a mild recession. But they caution that "in the event of a harsher global recession scenario we forecast far more significant downside."

How does 900 for the S&P 500 sound? Not good. That's where Goldman says the S&P 500 will end up in a worst-case scenario.

Merrill Lynch
December 2012 S&P 500 target: 1,350
This is another cautionary price target. Merrill actually predicted stocks would start the year on a solid note, but suggested investors shouldn't get complacent. "In the short term, we expect the New Year rally in risk assets to continue." Although analysts acknowledge that the still-unresolved European crisis may be seen as a drag, they still thought it prudent to "swim against the tide early in 2012 by betting on upside rather than downside, driven by bearish investor positioning and U.S. growth upgrades. A grind higher in stock prices remains plausible but we recommend taking profits if equity markets move toward our year-end targets of 1350 for the S&P 500."

UBS
December 2012 S&P 500 target: 1,325
Seeing a pattern emerge? This is another outlook that would suggest it's already time for profit-taking, predicting "2012 should again be a struggle between stronger domestic fundamentals and macro risks." Clearly, such macro risks aren't in evidence right now. Indeed, as of the very latest snapshot, it appears that Greece will strike a deal with creditors and avoid (or at least forestall) catastrophe.

The UBS forecasters raise another concern, and I am in complete agreement on this one. They predict "equities will struggle in the face of the European recession currently being forecast by UBS economists."

Conclusions...
While I am churlishly piling on these strategists for their cautious stance, I too have been a bit wary of this rally. I still think that European recessions, and not the currency crisis, hold the real threat to profits and stocks.

After watching the S&P 500 run from 1,160 in late November to 1,280 in mid-January, I grew nervous about what Europe will look like AFTER the debt/currency crisis is addressed. Addressing the weakest countries, I suggested that "it's hard to see how these lagging economies can avoid an even deeper economic retrenchment -- one which makes it hard to make a dent in debt burdens. And if that's the case, then continent-wide economic expansion will also grind lower."

Well, the S&P 500 has risen another 2% since then. That's likely attributable to continuing positive economic signs. Just this past week, we saw bullish reports on jobs, manufacturing and construction spending. Then again, fourth-quarter earnings have just been OK, and have not delivered the stellar upside we'd seen in recent quarters. For this rally to sustain throughout the year, quarterly profits -- and the U.S. economy -- will need to keep getting healthier.

Action to Take --> If you own any recent big gainers, then no one could blame you for taking profits. Short rallies should always be seen as an opportunity to raise cash so you have the funds to invest the next time the market pulls back.

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